The Congressional Budget Office (CBO) issued a warning on August 22 that highlights the critical dilemma faced by the US Congress.
Either the US economy will be thrown back into recession if Congress does not act to avert the fiscal cliff that will occur as current tax laws expire at the end of the year or, if Congress decides to extend current laws for one year, the country faces another year of budget deficit that exceeds $1 trillion.
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The two situations came clearly into focus as the CBO released its last budget and economic forecast before the election in November.
If current laws are allowed to expire, over 100 million Americans will experience a significant hike in their tax rates. The military and other government programs will be forced to slash spending by $100 billion.
On the plus side, this would make a drastic cut in the budget deficit from $1.13 trillion for the fiscal year ending September 2012 to $641 billion for fiscal 2013. The deficit’s representation of gross domestic product (GDP) would go from 7.3% to about 4%.
It would be the largest single year reduction since 1969. If Congress extends current laws for another year, the deficit’s representation of GDP would only shrink to 6.5%.
Unemployment would hover around 8%. And the economy would be projected to grow by 1.7%.
Another option is to cut spending and raise taxes more gradually. The Democratic plan to increase tax rates for those earning more than $250,000 per year would add $42 billion in tax collections for 2013 and $824 billion over the next decade.
Republicans in Congress advocate extending current laws for a year and making more spending cuts. The best result would be a compromise
between the two plans but this Congress is not known for working together. And there are no signs that members on either side of the aisle intend to do so.